Is Wall Street Trading Illegal?

A recent article the Financial Times (http://www.ft.com/cms/s/0/2924dd32-9c2e-11e0-acbc-00144feabdc0.html#axzz1Px5XUpW8) is about JP Morgan being sued for misleading investors. The SEC claims that that JP Morgan along with other financial institutions sold CDOs (Collateralized Debt Obligations) to clients but were misleading their clients. Also mentioned in the article was the case where Goldman Sachs was sued by the SEC for basically the same thing but Goldman’s case was based on mortgaged backed securities. Goldman Sachs won the lawsuit but had to pay a bunch of money in the end (http://www.marketwatch.com/story/goldman-sachs-beats-the-sec-2010-07-15 ).

Now the real question is whether or not financial institutions were wrong. CDOs and CMOs (Collateral Mortgage Obligations) are basically large pools of either debt or mortgages that are broken into tranches. The first tranche will receive payments first and once the first tranche is paid off then the second tranche will receive payments until they are paid off. As you can see the first tranche has the least risk and therefore is more expensive than the last tranches which are the riskiest but are also cheaper. With expensive versus cheap realize that the more risk you take (more risk equals cheaper) the higher the expected returns. Regardless of what information was given you can see that CDOs and CMOs are risky assets compared to standard stocks and bonds. Whether the information was accurate comes down to valuation methods which I think are irrelevant because the types of investors that bought these CDOs and CMOs are other financial institutions who should understand that CDOs and CMOs have higher amounts of risk and therefore have higher returns that other forms of debt such as bonds. Something else to consider is that the institutional investors make up about 95% of the market where individual investors make up the remaining 5%. Do you really think that institutional investors who have bought CDOs and CMOs don’t understand what they are? If they don’t understand the general risk they shouldn’t be purchasing the assets.

At the end of the day companies like JP Morgan and Goldman Sachs are in the right. They are buying and selling assets just like they should be. No financial institution should be sued for taking a bet against risky assets regardless if their clients bought them or someone else’s clients bought them. Many people view Wall Street as a bad place where people make bets and in reality anyone who makes an investment is making a bet. Wall Street is a place for economic growth and any company is subject to risk whether it is a start up or a 100 year old company. The idea that investors who lost money are trying to sue the other investor who sold it is outrageous.

In conclusion new regulations such as the Dodd Frank Bill and frivolous lawsuits are hurting the US economy by restricting free markets because investors are taking on risk, losing money, and then complaining that they didn’t win. For every investment there is a winner and a loser. If people feel that the markets are too risky and not regulated enough I suggest you stick with fixed income assets such as bonds or CDs. Wall Street should be allowed to take on risk and let the free markets determine who survives.

Is Gold an Irrational Exuberance?

Gold prices continue to rise due to bad economic news globally. In May gold reached a record of $1,518.10 an ounce. Is gold going to continue to rise and is it overvalued? Gold is not an investment but a tool for speculation and wealth storage. As investors have been weary of the equity markets and with the expectation that debt market rates will increase investors are moving their money to gold and silver.

            Gold is overvalued due to the global economic crises. To start, Greece is bankrupt and talk of a second bailout package seems very likely but European officials are saying it is not certain that this second package will happen. Even if the second package is granted, it is far from certain that Greece’s economy will recover. Along with the Greece crisis the US economy is growing slow and equity markets have been declining since April 29^th. The slow growth has also been affecting China’s growth since China sells a large amount of the goods they produce to the US.

            Gold might have a high price now but investors are weary that as global markets improve gold prices will drop. One sign that also points to gold being overvalued is that silver’s price has not been increasing as fast as gold. Silver is similar in that it can be used for speculation and wealth storage but it has not been increasing drastically like gold has. Gold has been increasing due to investors looking for a quick gain and the more gold prices have increased the more investors desire to invest as prices continue to increase. Investors that are now buying gold are either taking great risk in speculation or are poor investors since they will be buying high and selling low.

            Gold may continue to rise and as markets worsen but markets will get better as investors start to forget the past credit crisis and as other global crises cool down. From the evidence presented earlier in this post gold is clearly overvalued. Due to such an overvalue gold is clearly an irrational exuberance.